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Vertical Fiscal Imbalance and Local Fiscal Indiscipline: Empirical Evidence from China

Author

Listed:
  • Junxue Jia

    (Renmin University of China)

  • Yongzheng Liu

    (Renmin University of China)

  • Jorge Martinez-Vazquez

    (International Center for Public Policy, Georgia State University, USA)

  • Kewei Zhang

    (Boston University, USA)

Abstract

Based on a Chinese city-level panel dataset, this paper examines the effects of vertical fiscal imbalances (VFI) on local fiscal indiscipline in a partial fiscal decentralization setting. We find that higher VFI induces a form of fiscal indiscipline: a reduction of tax collection effort by local governments. In addition, by exploiting the unique Chinese fiscal institution of “extra-budgetary” revenues, we show that in this case higher VFI does not alter local governments’ tax collection efforts. Even though local governments also possess full taxing power for “extra-budgetary” revenues, these revenues do not contribute to the determination of central fiscal transfers to local governments, thus creating very different incentives for local governments’ response to VFI. Our results shed light on the working mechanism of VFI and provide significant implications for improving the design of fiscal decentralization policy in China and elsewhere.

Suggested Citation

  • Junxue Jia & Yongzheng Liu & Jorge Martinez-Vazquez & Kewei Zhang, 2020. "Vertical Fiscal Imbalance and Local Fiscal Indiscipline: Empirical Evidence from China," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper2006, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    • Handle: RePEc:ays:ispwps:paper2006
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    Cited by:

    1. Аnna A. Mikhaylova & Evgeny N. Timushev, 2021. "Concept of Vertical Fiscal Imbalance in the Analysis of Fiscal Sustainability at the Regional Level," Finansovyj žhurnal — Financial Journal, Financial Research Institute, Moscow 125375, Russia, issue 6, pages 98-116, December.
    2. Santiago Lago-Peñas & Jorge Martinez-Vazquez & Agnese Sacchi, 2020. "Fiscal stability during the Great Recession: putting decentralization design to the test," Regional Studies, Taylor & Francis Journals, vol. 54(7), pages 919-930, July.
    3. Li, Mo & Yang, Jing, 2024. "Can digital economy mitigate vertical fiscal imbalances in Chinese local government? The role of fiscal transparency," International Review of Financial Analysis, Elsevier, vol. 96(PB).
    4. Liangliang Liu & Wenqing Zhang, 2022. "Vertical fiscal imbalance and energy intensity in China," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 83(2), pages 509-526, October.
    5. Youshuai Sun & Demi Zhu & Zhenyu Zhang & Na Yan, 2022. "Does Fiscal Stress Improve the Environmental Efficiency? Perspective Based on the Urban Horizontal Fiscal Imbalance," IJERPH, MDPI, vol. 19(10), pages 1-23, May.
    6. Wei Li & Jie Li & Siwei Sun, 2023. "Influence of public credit risk on private capital in public–private partnership models," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 44(2), pages 1330-1343, March.
    7. Tianchu Feng & Meijuan Liu & Chaozhu Li, 2022. "How Does Vertical Fiscal Imbalance Affect CO 2 Emissions? The Role of Capital Mismatch," Sustainability, MDPI, vol. 14(17), pages 1-15, August.
    8. Liangliang Liu & Wenqing Zhang, 2022. "Vertical fiscal imbalance and government spending on science and technology in China," Economic Change and Restructuring, Springer, vol. 55(3), pages 1953-1971, August.
    9. Lin, Boqiang & Zhou, Yicheng, 2021. "Does fiscal decentralization improve energy and environmental performance? New perspective on vertical fiscal imbalance," Applied Energy, Elsevier, vol. 302(C).
    10. Klimanov, V. & Mikhaylova, A., 2021. "Fiscal decentralization in pandemic and post-pandemic times," Journal of the New Economic Association, New Economic Association, vol. 51(3), pages 218-226.
    11. Zhou, Shiyu & Luo, Weijie, 2024. "Pollution consequences of vertical fiscal imbalance: Evidence from China," International Review of Economics & Finance, Elsevier, vol. 92(C), pages 85-97.
    12. Kate Hynes & Yongzheng Liu & Jie Ma & Ian Wooton, 2022. "Tax competition for FDI: China’s exceptional approach," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 29(3), pages 788-809, June.
    13. Ryota Nakatani, 2023. "Sovereign Debt Crisis and Fiscal Devolution," JRFM, MDPI, vol. 17(1), pages 1-8, December.
    14. Shani, Ron & Reingewertz, Yaniv & Vigoda-Gadot, Eran, 2023. "Intergovernmental grants and local public finance: An empirical examination in Israel," European Journal of Political Economy, Elsevier, vol. 79(C).
    15. Manuel E. Lago & Santiago Lago-Peñas & Jorge Martinez-Vazquez, 2024. "On the effects of intergovernmental grants: a survey," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(3), pages 856-908, June.
    16. del Castillo, Ernesto & Cabral, René, 2024. "Subnational public debt sustainability in Mexico: Is the new fiscal rule working?," European Journal of Political Economy, Elsevier, vol. 82(C).
    17. Abolfazl Shahabadi & Maryam Heidarian, 2025. "The Effects of the Fiscal Stress Index and Knowledge Components on Environmental Quality," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 16(1), pages 3717-3740, March.
    18. Zhou, Yicheng & Lin, Boqiang, 2025. "The energy-saving effect of green fiscal policy: Empirical evidence from China's comprehensive demonstration cities of energy conservation and emission reduction fiscal policy," Applied Energy, Elsevier, vol. 378(PA).
    19. Hu, Zhifei & Liu, Xihe & Li, Xinyu & Wu, Jun, 2024. "How does vertical fiscal imbalance affect corporate green innovation? Empirical evidence from China," International Review of Financial Analysis, Elsevier, vol. 96(PA).
    20. Lin, Boqiang & Zhou, Yicheng, 2021. "How does vertical fiscal imbalance affect the upgrading of industrial structure? Empirical evidence from China," Technological Forecasting and Social Change, Elsevier, vol. 170(C).
    21. Yunchan Zhu & Shuo Han & Yimeng Zhang & Qi Huang, 2021. "Evaluating the Effect of Government Emission Reduction Policy: Evidence from Demonstration Cities in China," IJERPH, MDPI, vol. 18(9), pages 1-16, April.
    22. Ryota Nakatani, 2023. "Fiscal crises, decentralization, and indiscipline," Scottish Journal of Political Economy, Scottish Economic Society, vol. 70(5), pages 459-478, November.
    23. Xu Zhang & Tianchu Feng & Chengjun Wang & Chaozhu Li, 2023. "Local Fiscal Pressure and Public Health: Evidence from China," IJERPH, MDPI, vol. 20(6), pages 1-17, March.

    More about this item

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism

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